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SSNI > SEC Filings for SSNI > Form 10-Q on 8-May-2014All Recent SEC Filings

Show all filings for SILVER SPRING NETWORKS INC

Form 10-Q for SILVER SPRING NETWORKS INC


8-May-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013. In addition, the following discussion contains forward-looking statements that are based on our management's beliefs and assumptions and on information currently available to our management. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Factors that could cause or contribute to these differences include those factors discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly the section entitled "Risk Factors."

Overview

We have over ten years of experience creating, building and successfully deploying large scale networks and solutions enabling the "internet of things" for critical infrastructure. The "internet of things" refers to a system where a diversity of physical devices has the capacity to communicate using internet technologies. Our first area of focus was in energy, creating a leading smart grid network by applying advanced networking technology and solutions to the power grid. We have recently broadened beyond the smart grid to networking other critical infrastructure such as street lights, which enable smarter and more efficient cities.

For the smart grid, we provide a leading networking platform and solutions that enable utilities to transform the power grid infrastructure into the smart grid. The smart grid intelligently connects millions of devices that generate, control, monitor and consume power, providing timely information and control to both utilities and consumers. We believe that the application of networking technology to the power grid has the potential to transform the energy industry through better communication just as the application of networking technology to the computing industry enabled the Internet.

We believe the power grid is one of the most significant elements of contemporary industrial infrastructure that has yet to be extensively networked with modern technology. To address this challenge, we pioneered a fundamentally new approach to connect utilities with millions of devices on the power grid. We believe our technology will yield significant benefits to utilities, consumers and the environment, both in the near term and the future. These benefits include more efficient management of energy, improved grid reliability, capital and operational savings, integration with renewable-generation sources, consumer empowerment, and assistance in complying with evolving regulatory mandates through reduced carbon emissions. We believe networking the power grid will fundamentally transform the world's relationship with energy.

We believe our technology is particularly well suited for a range of other solutions across the broad category of the "internet of things." We are focused on critical infrastructure that requires similar networking performance as the current market we serve. Our first expansion beyond the power grid has been on city infrastructure, specifically networking street lights. We believe that by applying advanced networking technology, we can enable cities to achieve their goals for increasing energy and operating efficiency while improving quality of life. We expect to expand our offerings in this area as the market opportunity evolves.

We are an "emerging growth company," as defined in the Jumpstart Our Business Startups Act ("JOBS Act") enacted in April 2012. Under Section 107(b) of the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail our company of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.


Financial Overview

Revenue

We derive revenue from sales of products and services that enable customers to deploy our networking platform. For the three months ended March 31, 2014, product revenue represented 64% and service revenue represented 36% of our total revenue.

Our product revenue is derived from sales of hardware such as communications modules, access points, relays and bridges, and software. To date, in our typical customer deployments, we have sold our communications modules to third party device manufacturers and our other hardware and software products directly to our customers. However, when requested by our customers, we have sold third-party devices such as meters integrated with our communications modules directly to our customers.

Our service revenue includes fees for professional services, managed services and SaaS, and ongoing customer support.

To date, a substantial majority of our revenue is attributable to a limited number of customer deployments of our advanced metering solution. In the three months ended March 31, 2014, the deployments for Singapore Power, Progress Energy, and CHED represented 23%, 15%, and 15% of our revenue, respectively.

Each of these total revenue percentages includes amounts related to the customers' deployments that were invoiced directly to our third party device manufacturers, as well as direct revenue from our customers. We expect that a limited number of customers will continue to account for a substantial portion of our revenue in future periods although these customers have varied and are likely to vary from period to period.

Cost of Revenue and Gross Profit (Loss)

Product cost of revenue consists of contract manufacturing costs, including raw materials, component parts and associated freight, and normal yield loss in the period in which we recognize the related revenue. In addition, product cost of revenue includes compensation, benefits and stock-based compensation provided to our supply chain management personnel, and overhead and other direct costs, which are recognized in the period in which we recognize the related revenue. Further, we recognize certain costs, including logistics costs, manufacturing ramp-up costs, expenses for inventory obsolescence, warranty obligations, lower of cost or market adjustments to inventory, and amortization of intangibles, in the period in which they are incurred or can be reasonably estimated. We record a lower of cost or market adjustment in instances where the selling price of the products delivered or expected to be delivered is less than cost. We also include the cost of third-party devices in cost of revenue in instances when our customers contract with us directly for such devices. In accordance with our accounting policies, we recognize product cost of revenue in the periods we recognize the related revenue.

Service cost of revenue includes compensation and related costs for our service delivery, customer operations and customer support personnel, facilities and infrastructure cost and depreciation, and data center costs. In accordance with our accounting policies, we recognize service cost of revenue in the period in which it is incurred even though the associated service revenue may be required to be deferred.

Our gross profit (loss) varies from period to period based on the volume, average selling prices, and mix of products and services recognized as revenue, as well as product and service costs, expense for warranty obligations, and inventory write-downs. The timing of revenue recognition and related costs, which depends primarily on customer acceptance, can fluctuate significantly from period to period and have a material impact on our gross profit and gross margin results.

Operating Expenses

Operating expenses consist of research and development, sales and marketing, and general and administrative expenses, as well as amortization of acquired intangibles. Personnel-related expense represents a


significant component of our operating expenses. Our regular full-time employee headcount was 617 as of March 31, 2014.

Research and Development

Research and development expense represents the largest component of our operating expenses and consists primarily of:

compensation, benefits and stock-based compensation provided to our hardware and software engineering personnel, as well as facility costs and other related overhead;

cost of prototypes and test equipment relating to the development of new products and the enhancement of existing products; and

fees for design, testing, consulting, legal and other related services.

We expense our research and development costs as they are incurred.

Sales and Marketing

Sales and marketing expense consists primarily of:

compensation, benefits, sales commissions and stock-based compensation provided to our sales, marketing and business development personnel, as well as facility costs and other related overhead;

marketing programs, including expenses associated with industry events, trade shows; and

travel costs.

General and Administrative

General and administrative expense consists primarily of:

compensation, benefits and stock-based compensation provided to our executive, finance, legal, human resource and administrative personnel, as well as facility costs and other related overhead; and

fees paid for professional services, including legal, tax and accounting services.

Key Non-GAAP Financial Measures

We believe that our results of operations under GAAP, when considered in isolation, may only provide limited insight into the performance of our business in any given period. As a result, we manage our business, make planning decisions, evaluate our performance and allocate resources by assessing non-GAAP measures such as non-GAAP revenue, cost of non-GAAP revenue, gross profit on non-GAAP revenue, and adjusted EBITDA, in addition to other financial measures presented in accordance with GAAP. We believe that these non-GAAP measures offer valuable supplemental information regarding the performance of our business, and will help investors better understand the sales volumes, and gross margin and profitability trends, as well as the cash flow characteristics, of our business. These non-GAAP measures should not be considered in isolation from, are not a substitute for, and do not purport to be an alternative to revenue, cost of revenue, gross profit (loss), net income (loss) or any other performance measure derived in accordance with GAAP.

Non-GAAP revenue represents amounts invoiced for products for which ownership, typically evidenced by title and risk of loss, has transferred or services that have been provided to the customer, and for which payment is expected to be made in accordance with normal payment terms. Non-GAAP revenue excludes amounts for undelivered products, services to be performed in the future, and amounts paid or payable to customers. Non-GAAP revenue is initially recorded as deferred revenue and is recognized as revenue when all revenue recognition criteria have been met under our accounting policies. We reconcile revenue to non-GAAP revenue by adding revenue to the change in deferred revenue in a given period.

To date, a substantial portion of our non-GAAP revenue is attributable to a limited number of customer deployments of our advanced metering solution. In the three months ended March 31, 2014, the deployments for


Baltimore Gas and Electric Company, Florida Power and Light Company, Commonwealth Edison Company, and Virginia Power and Electric Company represented 23%, 12%, 10%, and 10% of our non-GAAP revenue, respectively.

Each of these total non-GAAP revenue percentages includes amounts related to the customers' deployments that were invoiced directly to our third party device manufacturers, as well as direct invoices to our customers.

Cost of Non-GAAP Revenue and Gross Profit on Non-GAAP Revenue

Cost of non-GAAP revenue represents the cost associated with products and services that have been delivered to the customer, excluding stock-based compensation and amortization of acquired intangibles. Cost of product shipments for which revenue is not recognized in the period incurred is recorded as deferred cost of revenue. Deferred cost of revenue is expensed in the statement of operations as cost of revenue when the corresponding revenue is recognized. Costs related to invoiced services are expensed in the period incurred. We reconcile cost of revenue to cost of non-GAAP revenue by adding cost of revenue to the change in deferred cost of revenue, less stock-based compensation and amortization of intangibles, included in cost of revenue in a given period.

Gross profit on non-GAAP revenue is the difference between non-GAAP revenue and cost of non-GAAP revenue.

Adjusted EBITDA is net income (loss) adjusted for changes in deferred revenue and deferred cost of revenue, other (income) expense, net, provision for income taxes, depreciation and amortization, stock-based compensation and certain other items management believes affect the comparability of operating results.

The non-GAAP financial measures set forth below for the three months ended March 31, 2014 and 2013 have been derived from our condensed consolidated financial statements. Reconciliations to the comparable GAAP measures are contained in the notes below.

                                           Three Months Ended
                                                March 31,
                                         2014               2013
                                       (unaudited, in thousands,
                                         except for percentages)
Non-GAAP revenue(1)                  $      71,850     $      73,771
Cost of non-GAAP revenue(2)                 50,302            52,220
Gross profit on non-GAAP revenue(3)  $      21,548     $      21,551
Gross margin on non-GAAP revenue               30%               29%
Adjusted EBITDA(4)                   $      (6,909)    $      (6,584)


(1)The following table reconciles revenue to non-GAAP revenue:

                                                               Three Months Ended
                                                                    March 31,
                                                             2014               2013
                                                            (unaudited, in thousands)
Revenue, net                                             $      44,229     $      53,703
Change in deferred revenue, net of foreign currency
translation                                                     27,621            20,068
Non-GAAP revenue                                         $      71,850     $      73,771

(2)The following table reconciles cost of revenue to cost of non-GAAP revenue:

                                                               Three Months Ended
                                                                    March 31,
                                                             2014               2013
                                                            (unaudited, in thousands)
Cost of revenue                                          $      32,785     $      43,569
Change in deferred cost of revenue, net of foreign
currency translation                                            20,257            15,423
Less: Stock-based compensation included in cost of
revenue                                                         (2,692)           (6,724)
Less: Amortization of intangibles included in cost of
revenue                                                            (48)              (48)
Cost of non-GAAP revenue                                 $      50,302     $      52,220


(3)The following table reconciles gross profit (loss) to gross profit on non-GAAP revenue:

                                                              Three Months Ended
                                                                  March 31,
                                                             2014             2013
                                                          (unaudited, in thousands)
Gross profit                                            $      11,444     $    10,134
Change in deferred revenue, net of foreign currency
translation                                                    27,621          20,068
Change in deferred cost of revenue, net of foreign
currency translation                                          (20,257)        (15,423)
Stock-based compensation included in cost of revenue            2,692           6,724
Amortization of intangibles included in cost of revenue            48              48
Gross profit on non-GAAP revenue                        $      21,548     $    21,551
Gross margin on non-GAAP revenue                                  30%             29%

(4)The following table reconciles net income (loss) to adjusted EBITDA:

                                                              Three Months Ended
                                                                  March 31,
                                                             2014             2013
                                                          (unaudited, in thousands)
Net loss                                                $     (27,807)    $   (64,366)
Change in deferred revenue, net of foreign currency
translation                                                    27,621          20,068
Change in deferred cost of revenue, net of foreign
currency translation                                          (20,257)        (15,423)
Other (income) expense, net                                        37          24,728
Provision for income taxes                                        599              64
Depreciation and amortization                                   1,466           1,677
Stock-based compensation                                       11,432          26,668
Adjusted EBITDA                                         $      (6,909)    $    (6,584)

Non-GAAP measures have limitations and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. The most significant of these limitations include:

our non-GAAP measures do not reflect the effect of customer acceptance provisions as required under GAAP;

our non-GAAP measures do not reflect the effect of contingent revenue recognition limits due to potential refunds and penalty provisions related to future delivery or performance as required under GAAP;

our non-GAAP measures are based on contractual invoiced amounts and therefore do not reflect the effect of relative selling price allocations between separate units of accounting as required under GAAP;

our non-GAAP measures do not reflect the impact of issuing equity-based compensation to our management team and employees or in connection with acquisitions;

our non-GAAP measures do not reflect the impact of the amortization of acquired intangibles arising from acquisitions;

our non-GAAP measures do not reflect other (income) expense primarily related to gains and losses from the remeasurement of embedded derivative and preferred stock warrant liabilities, and interest expense or loss on conversion from our promissory notes;

our non-GAAP measures do not reflect income tax expense or legal settlement costs;

although depreciation and amortization are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditures;

our non-GAAP measures do not reflect changes in, or cash requirements for, our working capital needs; and


other companies, including companies in our industry, may not use such measures, may calculate non-GAAP measures differently or may use other financial measures to evaluate their performance, all of which reduce the usefulness of our non-GAAP measures as comparative measures.

Results of Operations and Other Financial Measures

The following table sets forth our condensed consolidated results of operations
for the periods shown:






                                  Three Months Ended
                                       March 31,
                                  2014            2013
                               (unaudited, in thousands)
Revenue, net                 $      44,229     $   53,703
Cost of revenue                     32,785         43,569
Gross profit                        11,444         10,134

Operating expenses:
Research and development            17,725         25,119
Sales and marketing                  9,223         10,453
General and administrative          11,667         14,136
Total operating expenses            38,615         49,708
Operating loss                     (27,171)       (39,574)

Other income (expense), net:           (37)       (24,728)

Loss before income taxes           (27,208)       (64,302)
Provision for income taxes             599             64
Net loss                     $     (27,807)    $  (64,366)

Revenue

The following table sets forth our revenue for the periods shown:

                  Three Months Ended
                      March 31,
                   2014        2013        Change
                     (unaudited, in thousands)
Product revenue $  28,227    $ 41,720    $ (13,493)
Service revenue    16,002      11,983        4,019
Revenue, net    $  44,229    $ 53,703    $  (9,474)

Of the $44.2 million total revenue recognized in the three months ended March 31, 2014, 71%, or $31.3 million, was due to the receipt of customer acceptances and the performance of related services for follow-on phases of deployment of our networking platform and solutions from customers for which acceptance of initial phases of deployment was achieved prior to 2014, and 29%, or $12.9 million, was due to the receipt of customer acceptances of initial phases of deployment of our networking platform and solutions during 2014. Revenue from our advanced metering, and demand-side management and distribution automation solutions represented 90% and 10%, respectively, of total revenue for the three months ended March 31, 2014.

Of the $53.7 million total revenue recognized in the three months ended March 31, 2013, 88%, or $47.2 million, was due to the receipt of customer acceptances and the performance of related services for follow-on phases of deployment of our networking platform and solutions from customers for which acceptance of initial phases of deployment was achieved prior to 2013, and 12%, or $6.5 million, was due to the receipt of a customer acceptance of initial phase of deployment of our networking platform and solutions during 2013. Revenue from our advanced


metering, and demand-side management and distribution automation solutions represented 84% and 16%, respectively, of total revenue for the three months ended March 31, 2013.

Product Revenue. The $13.5 million decrease in product revenue for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 was due to lower acceptance volumes and changes in product mix.

Service Revenue. The $4.0 million increase in service revenue for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 was primarily due to an increase of $4.3 million for services associated with the receipt of customer acceptances for initial phases of deployment of our networking platform and solutions. Revenue from managed services and SaaS and professional services represented 17% and 19%, respectively, of total revenue for the three months ended March 31, 2014 and 8% and 14%, respectively, of total revenue for the three months ended March 31, 2013.

We anticipate that revenue will be lower sequentially in the three months ended June 30, 2014 and year-over-year for the three and six months ended June 30, 2014, and will fluctuate from period to period for the remainder of 2014 and beyond, and may lead to gross losses primarily due to the timing of when we expect to meet the completion and acceptance criteria in our customer arrangements.

Non-GAAP Revenue

The following table sets forth our non-GAAP revenue for the periods shown:

Three Months Ended
March 31,
2014 2013 Change

(unaudited, in thousands)

Non-GAAP revenue $ 71,850 $ 73,771 $ (1,921)


The $1.9 million decrease in non-GAAP revenue for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 was due to a decrease of $4.2 million from lower volumes partially offset by changes in product mix and an increase of $2.3 million in service revenue.

Non-GAAP revenue from our advance metering solution and demand-side management and distribution automation solutions represented 87% and 13%, respectively, for the three months ended March 31, 2014, and 93% and 7%, respectively, for the three months ended March 31, 2013.

Non-GAAP revenue from product, managed services and SaaS, and professional services represented 73%, 14%, and 13%, respectively, of total non-GAAP revenue for the three months ended March 31, 2014, and 76%, 12% and 12%, respectively, for the three months ended March 31, 2013.

We anticipate that non-GAAP revenue will be lower sequentially for the three months ended June 30, 2014 and year-over-year for the three and six months ended June 30, 2014 primarily due to continued effect of the long and unpredictable sales cycles of our existing and potential customers.

Cost of Revenue and Gross Profit

The following table sets forth our cost of revenue and gross profit (loss) for
the periods shown:






                              Three Months Ended
                                  March 31,
                               2014        2013        Change
                                 (unaudited, in thousands)
Product cost of revenue     $  17,915    $ 25,743    $  (7,828)
Service cost of revenue        14,870      17,826       (2,956)
Cost of revenue             $  32,785    $ 43,569    $ (10,784)

Product gross profit (loss) $  10,312    $ 15,977    $  (5,665)
Service gross profit (loss)     1,132      (5,843)       6,975
Gross profit                $  11,444    $ 10,134    $   1,310

. . .
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